I’m going to tell you a cold, hard fact about the stock market. Nobody knows with 100% certainty if it is going to go up, down, or sideways. Speculation is difficult…particularly about the future.
So what do you do about? Well, one thing NOT to do is worry about market direction. You’ve heard this before; Don’t worry about what you can’t control. You can’t control market direction so it is absolutely unhealthy to worry about it. Furthermore, what you can control, you can…so why worry about it!?
Here is what you can do though…Control Risk.
There are really two main schools of thought when it comes to controlling risk. The first and most common way people tend to control risk is through diversification. Essentially what you are attempting to control through diversification is volatility. If you are using this approach, it often times makes sense holding onto investments for extended periods of time and through thick and thin.
The second school of thought is controlling risk through absolute terms. With this approach, you are more worried about actual principle at risk. This approach employs strict buy and sell rules that you employ prior to taking action.
Neither school of thought is better or worse. Frankly, each one has it’s pros and cons. We of course diversify, but we absolutely employ absolute risk control strategies. The 5 main risk control tactics we use are the following:
1st – Decide if it is a risk on or risk off status – We decide if we are going to take buy or sell signals in the stock market. Our main indicator of this is 12-month momentum.
2nd – Decide where we would sell an investment if it goes against us. We establish a stop price.
3rd – Purchase the appropriate amount of the investment according to the overall risk to the portfolio.
4th – Purchase only half of the full position initially and possibly purchase the second half later if it meets the criteria.
5th – Stay Disciplined – We make plans that make sense, initiate them, and absolutely follow the plans without exception.
Finally, is it time to sell stocks according to our rules? Is it time to give up hope on the bull market continuing? Nope, not yet…12-month momentum remains positive although it is as close to turning negative as it has been in a very long time.
This week, we will continue to monitor our current positions. We don’t plan on taking on any new positions just quite yet. Have a great week!
Adam Straseske, CMT